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October 12, 2006

Time Warner Working Higher

Time Warner (TWX) closed at a 52 week high yesterday. In fact, it was the highest close since January 2005. I suspect that investors are looking ahead to 2007 and ignoring the poor performance of the total company in 2006. In 2007, the company’s fastest growing and largest division, cable distribution, will become an even larger part of the company now that the Adelphia acquisition is closed. Cable stocks have performed very well this year and M&A activity has supported even higher than current public market valuations.

TWX’s other divisions have much worse outlooks, although investors seem willing to look past their issues for now. AOL’s situation is well known. For now, investors appear willing to accept that cost cutting will limit the near-term damage to operating profits and that advertising growth will keep up with industry averages....

Cable network growth has really moderated of late. This is the company’s second largest division. Investors appear sanguine based on documented strength in scatter advertising over the past few months.

Filmed Entertainment has had a terrible year with especially weak performance from the movie studios. A strong slate of movies from this November’s Happy Feet through next year’s Harry Potter and Ocean’s Eleven sequels seems to have softened investor fears.

Publishing is a very slow growth business facing intense secular challenges. Again, investors concerns have been put aside by something to look forward to. In this case, a slimming down of the magazine portfolio is doing the trick.

Finally, I think investors are getting more comfortable with the overall scope of TWX’s restructuring actions. A recent report by Bernstein provided a unique and insightful look at this aspect of the TWX story. The basic theme of the report was that restructuring actions including the acquisition of Adelphia and Court TV, the sale of AOL Europe, and the magazine titles, and the closing of the WB Network effectively net out to TWX adding hundreds of millions of EBITDA at a multiple of less than 6 times. This analysis has the flaw of focusing on EBITDA and not considering the EPS dilutive of these transactions. However, in the long run, adding EBITDA translates into future earnings power from wholly controlled operating businesses. Investors are smart enough to value the long run over the short term in this case.

I’ve been back and forth on TWX. Most recently, I felt there was a good set up for a long side trade. Unlike many others I think the upside is limited to the low $20s. If the market remains decent, I think we might get the rest of the move sooner rather than later. Sentiment has finally turned on TWX and once a supertanker gets going in one direction it takes awhile for the momentum of the movement to stop.

Posted by Steve Birenberg at October 12, 2006 09:14 AM in TWX